MARGINAL PROPERTIES: HOW DO YOU SPELL RELIEF? RSFA?

• Jurisdiction: United States

Federal and Indian Oil and Gas Royalty Valuation and Management Book 1
(Feb 2004)
CHAPTER 11B
MARGINAL PROPERTIES: HOW DO YOU SPELL RELIEF? RSFA?
Sarah L. Inderbitzin ¹
Office of the Solicitor - Department of the Interior
Washington, D.C.

I. Introduction

There are approximately 500,000 producing oil wells in the United States. ¹ The "vast majority" of those wells are marginal ² or stripper wells. ³ In fact, the Independent Petroleum Association of America (IPAA) reports that there are approximately 433,000 marginal wells in the United States. ⁴

Why are marginal wells important? There are several reasons. First, marginal wells produce about 20% of all oil in the United States. ⁵ That is almost the same amount of oil we import from Saudi Arabia. ⁶ Moreover, marginal wells represent 43 percent of the recent increase in natural gas produced onshore in the lower 48 States. ⁷ Thus, they are a continuing source of domestic oil and gas production.

Second, "Ýe¨ven with today's technology, oil wells still typically leave 40 to 70 percent of the original oil in the reservoir." ⁸ Thus, if a marginal well is shutin, those reserves are lost forever because, in most instances, it is not economically feasible to redrill the well. ⁹

Finally, when a marginal well is shutin and reserves are abandoned, earnings are lost to the producer, refiners, transporters, and royalty interest holders. ¹⁰ More importantly, because oil consumption does not decrease when a marginal well is shutin, the United States makes up the difference by importing more oil. ¹¹ Thus, United States dollars are supporting other countries' economies, not our own. ¹²

II. What is the Solution?

A. State Incentive Programs

States have sought to keep marginal wells producing through various forms of relief in the form of tax breaks, royalty reduction, and regulatory relief. ¹³ These programs have resulted in $18.6 billion in industry investments in drilling and work-over activities. ¹⁴ As a result of these activities, in 1999, the number of plugged and abandoned marginal oil wells "dropped by nearly 2,700, the largest decrease by far in the number of idled wells in the past decade." ¹⁵ This led to an increase in producing marginal wells, which in turn resulted in a production increase from 315,514,000 barrels of oil in 1999 to 326,208,000 barrels in 2000. ¹⁶ The overall impact of the states' $2.5 billion dollar incentive and relief investment was to create jobs and "pumpݨ 30 times that much into the economy." ¹⁷ Thus, incentives and relief work.

B. The Royalty Simplification and Fairness Act of 1996 (RSFA) ¹⁸

Congress's attempt to provide incentives and relief to keep marginal wells on Federal lands producing is contained in RSFA. ¹⁹ RSFA authorizes royalty prepayments ²⁰ and regulatory relief ²¹ for marginal properties if the State concerned ²² consents to relief for marginal production. ²³ If royalty payments from a lease are not shared with a State under applicable law, such as offshore leases not subject to Section 8(g) of the Outer Continental Shelf Lands Act, ²⁴ then the Secretary alone determines whether to provide relief. ²⁵ RSFA did not provide examples of specific accounting and auditing relief, so Congress left it to MMS to develop various forms of relief, and a methodology for calculating prepayments.

II. MMS's Rulemakings Implementing RSFA

In response to the RSFA Section 7 amendments, MMS conducted three workshops to receive input regarding proposing rules implementing that Section. ²⁶ MMS then used the input from those workshops to develop the 1999 Proposed Rule "Accounting and Auditing Relief for Marginal Properties." ²⁷ After receiving comments on the 1999 Proposed Rule, with States saying the rule provided too much relief, and industry saying too little relief, MMS asked the Royalty Policy Committee (RPC) ²⁸ to form a subcommittee to make recommendations regarding marginal property relief (Subcommittee). ²⁹ The Subcommittee prepared an Accounting and Auditing Relief Report and Prepayment of Royalty Report, and submitted the reports to the RPC. ³⁰ The RPC accepted the Subcommittee's recommendations for accounting and auditing relief and prepayment relief. ³¹ MMS approved the Accounting and Auditing Relief Report and proposed a Supplementary Proposed Rule incorporating the Subcommittee's recommendations. ³²

A. General Provisions

The 1999 Proposed Rule and Supplementary Proposed Rule would implement Sections 7(a) and 7(c) of RSFA. ³³ Although Section 7 of RSFA provides two alternatives for marginal properties, one for prepayment of royalty, ³⁴ and one for accounting and auditing relief, ³⁵ the 1999 Proposed Rule addressed only the general provisions for marginal properties ³⁶ and the accounting and auditing relief provisions. ³⁷ Although MMS reserved the right to publish a proposed rule covering prepayment of royalty at a later date, MMS stated that the "General Provisions" contained in Subpart A of the 1999 Proposed Rule "would provide general requirements for both prepayment of royalty under section 7(b) of RSFA and accounting and auditing relief under section 7(c) of RSFA." ³⁸

What is a "Marginal Property?" 1.

Webster's Dictionary defines "marginal" as "enterprises that produce goods at a rate that barely covers production costs." ³⁹ Most oil and gas producers would agree that this definition aptly describes their marginal properties! ⁴⁰ Yet, when it comes to quantifying what constitutes "marginal production" for purposes of relief the definitions vary from jurisdiction to jurisdiction, ⁴¹ and even within scholarly sources. ⁴² This article addresses the Federal definition of "marginal property" used for purposes of marginal property relief under Section 7 of RSFA ⁴³

RSFA Section 7(a) requires that MMS and the State "jointly determine, on a case-by-case basis, the amount of what marginal production from a lease or leases or well or wells, or parts thereof" may obtain royalty prepayment or accounting and auditing relief. ⁴⁴ RSFA does not define marginal properties for purposes of marginal property relief under Section 7 of RSFA. However, RSFA does define marginal properties under Section 6(d)(4), which provides an exception to the requirement that lessees or designees report and pay on their entitlement volume each month if the property qualifies as a "marginal property." ⁴⁵ Section 6(d)(4) defines a "marginal property" as a "lease that produces on average the combined equivalent of less than 15 barrels of oil per well per day or 90 thousand cubic feet of gas per well per day, or a combination thereof." ⁴⁶ In addition, under Section 6(d)(4), the production level is calculated "by dividing the average daily production of crude oil and natural gas from producing wells on such leases by the number of such wells, unless the Secretary, together with the State concerned, determine that a different production is more appropriate." ⁴⁷

In order to be consistent with Section 6(d)(4) of RSFA, ⁴⁸ as well as to apply a consistent standard nationwide, MMS proposed to use the production level in the definition of "marginal properties" in Section 6(d)(4) as the basis for what amount of marginal production qualifies a property as "marginal" for purposes of relief under RSFA Section 7. ⁴⁹ In fact, in one of several workshops MMS conducted to develop the proposed rule, some participants stated that MMS should consider using the RSFA Section 6(d)(4) production levels for marginal properties as the production level for marginal property relief. ⁵⁰ Other participants believed that using RSFA Section 6(d)(4) production levels would "qualify too many properties as marginal, and result in an unmanageable workload for MMS and States." ⁵¹ Still others advocated that MMS should use State incentive program production levels to qualify Federal properties as marginal. ⁵² Comments to the 1999 Proposed Rule largely reiterated the suggestions received at the workshops. ⁵³

As discussed above, each State definition of the production level that qualifies as "marginal" is unique. ⁵⁴ Thus, as MMS explained in the 1999 Proposed Rule, using State production levels "would require MMS to develop different production levels for each State with incentive programs, for States without incentive programs, and for offshore production ...." ⁵⁵ Accordingly, from an administrative perspective, using the production levels set forth in RSFA Section 6(d) makes sense. ⁵⁶ It is less administratively onerous to define Federal marginal properties using the single production level in RSFA Section(6)(d) ⁵⁷ than the varying production levels based on where a lease is located that would result from using State incentive program production levels. ⁵⁸ The Subcommittee agreed, and recommended keeping the definition of "marginal property" contained in the 1999 Proposed Rule. ⁵⁹

In its 1999 Proposed Rule and Supplementary Proposed Rule, MMS explained that using RSFA Section 6(d)(4) production levels to define "marginal" properties for purposes of relief under RSFA Section 7 also is consistent with Section 7's requirement that MMS and States "jointly determine" on a "case-by-case" basis production levels for which to grant relief. ⁶⁰ RSFA explicitly states that "if the State concerned does not consent . . . relief shall not be made available under this section for such marginal production." ⁶¹ That is exactly what the Supplementary Proposed Rule does. It establishes a marginal production level that States may either consent to or not. ⁶² If States do not consent, they may decline to offer relief, and MMS will not make relief available for such marginal production. ⁶³ Thus, States that wish to offer relief can unite with MMS by jointly offering relief at the production level established in the rule. ⁶⁴

With respect to determining production levels on a "case-by-case" basis, the fact that MMS and States offer relief at a set production level meets this...